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Chapter 16 8. Documenting an Export of Hard Drives. List the steps involved in the export of computer hard disk drives from Penang, Malaysia, to San Jose, California, using an unconfirmed letter of credit authorizing payment on sight. 9. Documenting an Export of Lumber from Portland to Yokohama. List the steps involved in the export of lumber from Portland, Oregon, to Yokohama, Japan, using a confirmed letter of credit, payment to be made in 120 days. 10. Governmentally Supplied Credit. Various governments have established agencies to insure against nonpayment for exports and/or to provide export credit. This shifts credit risk away from private banks and to the citizen taxpayers of the country whose government created and backs the agency. Why would such an arrangement be of benefit to the citizens of that country? 1.Nikken Microsystems (A). Assume Nikken Microsystems has sold Internet servers to Telecom Espaa for 700,000. Payment is due in three months and will be made with a trade acceptance from Telecom Espaa Acceptance. The acceptance fee is 1.0% per annum of the face amount of the note. This acceptance will be sold at a 4% per annum discount. What is the annualized percentage all-in cost in euros of this method of trade financing? 2. Nikken Microsystems (B). Assume that Nikken Microsystems prefers to receive U.S. dollars rather than euros for the trade transaction described in Problem 1. It is considering two alternatives: (1) sell the acceptance for euros at once and convert the euros immediately to U.S. dollars at the spot rate of exchange of $1.00/ or (2) hold the euro acceptance until maturity but at the start sell the expected euro proceeds forward for dollars at the 3-month forward rate of $1.02/. a. What are the U.S. dollar net proceeds received at once from the discounted trade acceptance in alternative 1? b. What are the U.S. dollar net proceeds received in three months in alternative 2? c. What is the break-even investment rate that would equalize the net U.S. dollar proceeds from both alternatives? d. Which alternative should Nikken Microsystems choose? 12. Swishing Shoe Company. Swishing Shoe Company of Durham, North Carolina, has received an order for 50,000 cartons of athletic shoes from Southampton Footware, Ltd., of England, payment to be in British pounds sterling. The shoes will be shipped to Southampton Footware under the terms of a letter of credit issued by a London bank on behalf of Southampton Footware. The letter of credit specifies that the face value of the shipment, 400,000, will be paid 120 days after the London bank accepts a draft drawn by Southampton Footware in accordance with the terms of the letter of credit. The current discount rate in London on 120-day bankers' acceptances is 12% per annum, and Southampton Footware estimates its weighted average cost of capital to be 18% per annum. The commission for selling a bankers' acceptance in the discount market is 2.0% of the face amount. a. Would Swishing Shoe Company gain by holding the acceptance to maturity, as compared to discounting the bankers' acceptance at once? b. Does Swishing Shoe Company incur any other risks in this transaction chapter 17 3. Competitive Advantage. In deciding whether to invest abroad, management must first determine whether the firm has a sustainable competitive advantage that enables it to compete effectively in the home market. What are the necessary characteristics of this competitive advantage? 17. Operating Strategies after the FDI Decision. The following operating strategies, among others, are expected to reduce damage from political risk. Explain each and how it reduces damage. a. Local sourcing b. Facility location c. Control of technology d. Thin equity base e. Multiple-source borrowing 24. Global-Specific Risks. What are the main types of political risks that are global in origin? Chapter 18 10. Cost of Equity. A foreign subsidiary does not have an independent cost of capital. However, in order to estimate the discount rate for a comparable host-country firm, the analyst should try to calculate a hypothetical cost of capital. How is this done? 11. Viewpoint Cash Flows. What are the differences in the cash flows used in a project point of view analysis and a parent point of view analysis? 1. Carambola de Honduras. Slinger Wayne, a U.S.-based private equity firm, is trying to determine what it should pay for a tool manufacturing firm in Honduras named Carambola. Slinger Wayne estimates that Carambola will generate a free cash flow of 13 million Honduran lempiras (Lp) next year (2012), and that this free cash flow will continue to grow at a constant rate of 8.0% per annum indefinitely. A private equity firm like Slinger Wayne, however, is not interested in owning a company for long, and plans to sell Carambola at the end of three years for approximately 10 times Carambola's free cash flow in that year. The current spot exchange rate is Lp14.80/$, but the Honduran inflation rate is expected to remain at a relatively high rate of 16.0% per annum compared to the U.S. dollar inflation rate of only 2.0% per annum. Slinger Wayne expects to earn at least a 20% annual rate of return on international investments like Carambola. a. What is Carambola worth if the Honduran lempira were to remain fixed over the three year investment period? b. What is Carambola worth if the Honduran lempira were to change in value over time according to purchasing power parity? 5. Doohicky Devices. Doohickey Devices, Inc., manufactures design components for personal computers. Until the present, manufacturing has been subcontracted to other companies, but for reasons of quality control Doohicky has decided to manufacture itself in Asia. Analysis has narrowed the choice to two possibilities, Penang, Malaysia, and Manila, the Philippines. At the moment only the summary of expected, aftertax, cash flows displayed at the bottom of this page is available. Although most operating outflows would be in Malaysian ringgit or Philippine pesos, some additional U.S. dollar cash outflows would be necessary, as shown in the table at the top of the next page. The Malaysia ringgit currently trades at RM3.80/$ and the Philippine peso trades at Ps50.00/$. Doohicky expects the Malaysian ringgit to appreciate 2.0% per year against the dollar, and the Philippine peso to depreciate 5.0% per year against the dollar. If the weighted average cost of capital for Doohicky Devices is 14.0%, which project looks most promising? \fPrepare, Apply, and Confirm E \u0007 nhanced eText FeaturesKeep students engaged in learning on their own time, while helping them achieve greater conceptual understanding of course material through authorcreated solutions videos and animations. Dynamic Study ModulesWork by continuously assessing student performance and activity, then using data and analytics to provide personalized content in real time to reinforce concepts that target each student's particular strengths and weaknesses. \u0007 allmark FeaturesPersonalized Learning Aids, like H Help Me Solve This, View an Example, and instant feedback are available for further practice and mastery when students need the help most! L \u0007 earning CatalyticsGenerates classroom discussion, guides lecture, and promotes peer-to-peer learning with real-time analytics. Now, students can use any device to interact in the classroom. A \u0007 daptive Study PlanAssists students in monitoring their own progress by offering them a customized study plan powered by Knewton, based on Homework, Quiz, and Test results. Includes regenerated exercises with unlimited practice and the opportunity to prove mastery through quizzes on recommended learning objectives. A00_MOFF9872_14_SE_FEP.indd 2-3 with MyFinanceLab W \u0007 orked SolutionsProvide step-by-step explanations on how to solve select problems using the exact numbers and data that were presented in the problem. Instructors will have access to the Worked Solutions in preview and review mode. A \u0007 lgorithmic Test BankInstructors have the ability to create multiple versions of a test or extra practice for students. \u0007Financial CalculatorThe Financial Calculator is available as a smartphone application, as well as on a computer, and includes important functions such as cash flow, net present value, and internal rate of return. Fifteen helpful tutorial videos show the many ways to use the Financial Calculator in MyFinanceLab. 123 R \u0007 eporting DashboardView, analyze, and report learning outcomes clearly and easily. Available via the Gradebook and fully mobile-ready, the Reporting Dashboard presents student performance data at the class, section, and program levels in an accessible, visual manner. \u0007LMS IntegrationLink from any LMS platform to access assignments, rosters, and resources, and synchronize MyLab grades with your LMS gradebook. For students, new direct, single sign-on provides access to all the personalized learning MyLab resources that make studying more efficient and effective. M \u0007 obile ReadyStudents and instructors can access multimedia resources and complete assessments right at their fingertips, on any mobile device. 12/06/15 11:13 pm Prepare, Apply, and Confirm E \u0007 nhanced eText FeaturesKeep students engaged in learning on their own time, while helping them achieve greater conceptual understanding of course material through authorcreated solutions videos and animations. Dynamic Study ModulesWork by continuously assessing student performance and activity, then using data and analytics to provide personalized content in real time to reinforce concepts that target each student's particular strengths and weaknesses. \u0007 allmark FeaturesPersonalized Learning Aids, like H Help Me Solve This, View an Example, and instant feedback are available for further practice and mastery when students need the help most! L \u0007 earning CatalyticsGenerates classroom discussion, guides lecture, and promotes peer-to-peer learning with real-time analytics. Now, students can use any device to interact in the classroom. A \u0007 daptive Study PlanAssists students in monitoring their own progress by offering them a customized study plan powered by Knewton, based on Homework, Quiz, and Test results. Includes regenerated exercises with unlimited practice and the opportunity to prove mastery through quizzes on recommended learning objectives. A00_MOFF9872_14_SE_FEP.indd 2-3 with MyFinanceLab W \u0007 orked SolutionsProvide step-by-step explanations on how to solve select problems using the exact numbers and data that were presented in the problem. Instructors will have access to the Worked Solutions in preview and review mode. A \u0007 lgorithmic Test BankInstructors have the ability to create multiple versions of a test or extra practice for students. \u0007Financial CalculatorThe Financial Calculator is available as a smartphone application, as well as on a computer, and includes important functions such as cash flow, net present value, and internal rate of return. Fifteen helpful tutorial videos show the many ways to use the Financial Calculator in MyFinanceLab. 123 R \u0007 eporting DashboardView, analyze, and report learning outcomes clearly and easily. Available via the Gradebook and fully mobile-ready, the Reporting Dashboard presents student performance data at the class, section, and program levels in an accessible, visual manner. \u0007LMS IntegrationLink from any LMS platform to access assignments, rosters, and resources, and synchronize MyLab grades with your LMS gradebook. For students, new direct, single sign-on provides access to all the personalized learning MyLab resources that make studying more efficient and effective. M \u0007 obile ReadyStudents and instructors can access multimedia resources and complete assessments right at their fingertips, on any mobile device. 12/06/15 11:13 pm Multinational Business Finance F o u r t e e n t h E D I T I ON A01_MOFF9872_14_SE_FM.indd 1 12/06/15 10:02 pm The Pearson Series in Finance Berk/DeMarzo Corporate Finance* Corporate Finance: The Core* Berk/DeMarzo/Harford Fundamentals of Corporate Finance* Brooks Financial Management: Core Concepts* Copeland/Weston/Shastri Financial Theory and Corporate Policy Dorfman/Cather Introduction to Risk Management and Insurance Eakins/McNally Corporate Finance Online* Eiteman/Stonehill/Moffett Multinational Business Finance* Fabozzi Bond Markets: Analysis and Strategies Fabozzi/Modigliani/Jones Foundations of Financial Markets and Institutions Foerster Financial Management: Concepts and Applications* Frasca Personal Finance Gitman/Zutter Principles of Managerial Finance* Principles of Managerial FinanceBrief Edition* Haugen The Inefficient Stock Market: What Pays Off and Why Modern Investment Theory Holden Excel Modeling in Corporate Finance Excel Modeling in Investments Hughes/MacDonald International Banking: Text and Cases Hull Fundamentals of Futures and Options Markets Options, Futures, and Other Derivatives Keown Personal Finance: Turning Money into Wealth* Keown/Martin/Petty Foundations of Finance: The Logic and Practice of Financial Management* Madura Personal Finance* Marthinsen Risk Takers: Uses and Abuses of Financial Derivatives McDonald Derivatives Markets Fundamentals of Derivatives Markets Mishkin/Eakins Financial Markets and Institutions Moffett/Stonehill/Eiteman Fundamentals of Multinational Finance Nofsinger Psychology of Investing Pennacchi Theory of Asset Pricing Rejda/McNamara Principles of Risk Management and Insurance Smart/Gitman/Joehnk Fundamentals of Investing* Solnik/McLeavey Global Investments Titman/Keown/Martin Financial Management: Principles and Applications* Titman/Martin Valuation: The Art and Science of Corporate Investment Decisions Weston/Mitchell/Mulherin Takeovers, Restructuring, and Corporate Governance *denotes MyFinanceLab titles Log onto www.myfinancelab.com to learn more A01_MOFF9872_14_SE_FM.indd 2 12/06/15 10:02 pm Multinational Business Finance F o u r t e e n t h Edi t i o n David K. Arthur I. Michael H. Eiteman Stonehill Moffett University of California, Los Angeles Oregon State University and University of Hawaii at Manoa Thunderbird School of Global Management at Arizona State University BostonColumbusIndianapolisNew YorkSan Francisco AmsterdamCape TownDubaiLondonMadridMilanMunichParisMontrealToronto DelhiMexico CitySao PauloSydneyHong KongSeoulSingaporeTaipeiTokyo A01_MOFF9872_14_SE_FM.indd 3 12/06/15 10:02 pm Vice President, Business Publishing: Donna Battista Acquisitions Editor: Kate Fernandes Editorial Assistant: Kathryn Brightney Vice President, Product Marketing: Maggie Moylan Director of Marketing, Digital Services and Products: Jeanette Koskinas Senior Product Marketing Manager: Alison Haskins Executive Field Marketing Manager: Adam Goldstein Team Lead, Program Management: Ashley Santora Program Manager: Kathryn Dinovo Team Lead, Project Management: Jeff Holcomb Project Manager: Meredith Gertz Operations Specialist: Carol Melville Creative Director: Blair Brown Art Director: Jon Boylan Vice President, Director of Digital Strategy and Assessment: Paul Gentile Manager of Learning Applications: Paul DeLuca Digital Editor: Megan Rees Director, Digital Studio: Sacha Laustsen Digital Studio Manager: Diane Lombardo Digital Studio Project Manager: Melissa Honig Product Manager: Elizabeth Cameron Digital Content Team Lead: Noel Lotz Digital Content Project Lead: Miguel Leonarte Project Management and Text Design: Gillian Hall Composition and Art Creation: Laserwords Maine Cover Designer: Joyce Wells Cover Art: iStock by Getty Images/chinaface Printer/Binder: Edwards Brothers Malloy Cover Printer: Phoenix Color/Hagerstown Copyright 2016, 2013, 2010 by Pearson Education, Inc. or its affiliates. All Rights Reserved. Manufactured in the United States of America. This publication is protected by copyright, and permission should be obtained from the publisher prior to any prohibited reproduction, storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise. For information regarding permissions, request forms, and the appropriate contacts within the Pearson Education Global Rights and Permissions department, please visit www.pearsoned.com/permissions/. Acknowledgments of third-party content appear on the appropriate page within the text, which constitutes an extension of this copyright page. PEARSON, ALWAYS LEARNING, and MYFINANCELABTM are exclusive trademarks owned by Pearson Education, Inc. or its affiliates in the U.S. and/or other countries. Unless otherwise indicated herein, any third-party trademarks that may appear in this work are the property of their respective owners, and any references to third-party trademarks, logos, or other trade dress are for demonstrative or descriptive purposes only. Such references are not intended to imply any sponsorship, endorsement, authorization, or promotion of Pearson's products by the owners of such marks, or any relationship between the owner and Pearson Education, Inc. or its affiliates, authors, licensees, or distributors. Library of Congress Cataloging-in-Publication Data Eiteman, David K. Multinational business finance / David K. Eiteman, University of California, Los Angeles, Arthur I. Stonehill, Oregon State University and the University of Hawaii at Manoa, Michael H. Moffett, Thunderbird School of Global Management.Fourteenth edition. pages cm Includes index. ISBN 978-0-13-387987-2 1. International business enterprises--Finance. I. Stonehill, Arthur I. II. Moffett, Michael H. III. Title. HG4027.5.E36 2015 658.15'99--dc23 2015020241 10987654321 ISBN-13:978-0-13-387987-2 ISBN-10: 0-13-387987-9 A01_MOFF9872_14_SE_FM.indd 4 12/06/15 10:02 pm Preface Multinational Business Finance, Fourteenth Edition, continues to evolve as the global business and financial environment it describes evolves. Institutions, markets, and business itself are changing rapidly, challenging many long-held assumptions of financial management. We have chosen to design the content of this edition along three points of emphasis. Organizations of All Kinds. Multinational enterprises (MNEs) applies to organizations of all kindsthe publicly traded, the privately held, the state-run, the stateowned organizationsall forms that permeate global business today. Role of Emerging Markets. Firms from all countries and all markets are looking to the economic drivers of the global economy today, the emerging markets, and the many new roles they play in terms of competition and opportunity. These markets present a multitude of specific risks and challenges for multinational business and finance. Financial Leadership. The leaders of MNEs face numerous foreign exchange and political risks. These risks can be daunting but they also present opportunities for creating value if properly understood. These opportunities and risks are most effectively understood in the context of the global business itself, and the ability of management to integrate the strategic and financial challenges that business faces. New in the Fourteenth Edition The theme for this Fourteenth Edition could in some ways be considered an emerging market strength, weakness, opportunity, threat (SWOT) analysis. A world in which the developed or industrialized countries see slower growth, poorer job opportunities, and a growing insecurity over their competitiveness in the global marketplace, but emerging markets offer promise and risk. A short overview of the features in the Fourteenth Edition can be segmented into structure and teaching, content and theoretical structures, and new Mini-Case offerings. Book Structure and Teaching A01_MOFF9872_14_SE_FM.indd 5 All chapters are structured around a series of pedagogical Learning Objectives aligned with the MyFinanceLab platform for Multinational Business Finance's teaching. An increased focus is placed on how multinational firms financially operate similarly/ differently across industrial markets and emerging markets. A new chapter, Chapter 8, is devoted solely to interest rate risk and interest rate risk management, with a focus on the use of interest rate and cross-currency swaps. A multitude of new Mini-Cases explore the current global financial market's many challenges. End-of-chapter questions and problems are revised throughout, aligned with MyFinanceLab, and cover the gamut of the increasing complexity of how multinational enterprisesfor profit and not-for-profitoperate and compete globally. v 12/06/15 10:02 pm vi Preface Content and Theoretical Structures Two-level chapter structure is offered with primary chapter content focused on critical components of multinational corporate finance. Selected second-level complexity of chapter content is delivered in appendices devoted to topics such as algebraic derivation of international parity conditions, foreign currency option pricing theory, advanced topics in transaction exposure hedging, foreign subsidiary funding and capitalization, among others. Use of fundamental theoretical foundations is expanded like that of the foreign currency/interest rate box diagram and the triangular structure of the Impossible Trinity. Selected business and industry practices are delivered in Global Finance in Practice boxes in each chapter that both support and on occasion oppose theoretical principles in international finance. New Chapter Mini-Cases Nine of the 18 chapter Mini-Cases in the fourteenth edition are new: Chapter 1 on Multinational Financial Management: Crowdfunding Kenya Chapter 2 on the International Monetary System: Iceland: A Small Country in a Global Crisis Chapter 5 on the Balance of Payments: Global Remittances Chapter 7 on Foreign Currency Futures and Options: KiKos and the South Korean Won Chapter 8 on Interest Rate Derivatives and Swaps: Argentina and the Vulture Funds Chapter 9 on Exchange Rate Determination: Russian Ruble Roulette Chapter 10 on Transaction Exposure: China Noah Corporation Chapter 15 on Multinational Tax Management: Apple's Global iTax Strategy Chapter 18 on Multinational Capital Budgeting and Cross-Border Acquisition: Elan and Royalty Pharma A final note on style. International finance is a subject of sophistication, constant change, yet rich in history. We have tried to bridge the past and future with a mix of currency notations and symbols throughout the book, using both the increasingly common three-letter currency codesUSD, CNY, EURwith the currency symbols of the past$, , , which live on in modern media. Audience Multinational Business Finance, Fourteenth Edition, is aimed at university-level courses in international financial management, international business finance, international finance, and similar titles. It can be used at either the undergraduate or graduate level as well as in executive education and corporate learning courses. A prerequisite course or experience in corporate finance or financial management would be ideal. However, we review the basic finance concepts before we extend them to the multinational case. We also review the basic concepts of international economics and international business. Over many years and many editions, as language translations and sales have expanded, we have observed a widening global audience for this book. We continue to try to service this A01_MOFF9872_14_SE_FM.indd 6 12/06/15 10:02 pm Preface vii greater global audience with multicountry companies and markets in theoretical applications, examples, Mini-Cases, and Global Finance in Practice features, as seen in the business and news press (including anecdotes and illustrations). Organization Multinational Business Finance, Fourteenth Edition, has a number of new subjects, but is also shorter. This has been accomplished by integrating a number of previous topics along financial management threads. The book is in five parts, the parts unified by the common thread of the globalization process by which a firm moves from a domestic to a multinational business orientation. Part 1 introduces the global financial environment Part 2 explains foreign exchange theory and markets Part 3 analyzes foreign exchange exposure Part 4 explores the financing of the global firm Part 5 analyzes foreign investments and operations Pedagogical Tools To make Multinational Business Finance, Fourteenth Edition, as comprehensible as possible, we use a large number of proven pedagogical tools. Again, our efforts have been informed by the detailed reviews and suggestions of a panel of professors who are recognized individually for excellence in the field of international finance, particularly at the undergraduate level. Among these pedagogical tools are the following: A01_MOFF9872_14_SE_FM.indd 7 A student-friendly writing style is utilized combined with a structured presentation of material, beginning with learning objectives for each chapter, and ending with a summarization of how those learning objectives were realized. A wealth of illustrations and exhibits provide a visual parallel to the concepts and content presented. A running case on a hypothetical U.S.-based firm, Trident Corporation, provides a cohesive framework for the multifaceted globalization process, and is reinforced in several end-of-chapter problems. A Mini-Case at the end of each chapter illustrates the chapter (18 in all) content and extends it to the multinational financial business environment. And as noted, 9 of the 18 Mini-Cases in the Fourteenth Edition are new. Global Finance in Practice boxes in every chapter illuminate the theory with accounts of actual business practices. These applications extend the concepts without adding to the length of the text itself. The power and resources of the Internet are leveraged throughout the text in a variety of applications. Every chapter has a number of end-of-chapter exercises requiring the use of the Internet, while a variety of Internet references are dispersed throughout the chapters in text and exhibits. A multitude of end-of-chapter questions and problems, which assess the students' understanding of the course material, are included. All end-of-chapter problems are solved using spreadsheet solutions. Selected end-of-chapter problem answers are included at the back of the book. 12/06/15 10:02 pm viii Preface A Rich Array of Support Materials A robust package of materials for both instructor and student accompanies the text to facilitate learning and to support teaching and testing. MyFinanceLab. Multinational Business Finance, Fourteenth Edition, is now available with MyFinanceLab. MyFinanceLab, a fully integrated homework and tutorial system, solves one of the biggest teaching problems in finance courses: providing students with unlimited practice homework problems along with a structured blueprint for studying the material. MyFinanceLab offers: Textbook problems online Algorithmically generated values for more practice Partial credit Personalized study plans Extra help for students Online gradebook End-of-chapter Questions and Problems that provide assessment and practice opportunities, are available in MyFinanceLab. Internet exercises, glossary flash cards, and Web links are also available in MyFinanceLab. Online Instructor's Resource Manual. The Online Instructor's Resource Manual, prepared by the authors, contains complete answers to all end-of-chapter questions, problems, and chapter Mini-Cases. All quantitative end-of-chapter problems are solved using spreadsheets, which are also available online. Online Test Bank. The Online Test Bank, prepared by Rodrigo Hernandez, Radford University, College of Business and Economics, contains over 1,200 multiple-choice and short-essay questions. The multiple-choice questions are labeled by topic and by category-recognition, conceptual, and analytical types. Computerized Test Bank. The Test Bank is also available in Pearson Education's TestGen Software. Fully networkable, it is available for Windows and Macintosh. TestGen's graphical interface enables instructors to view, edit and add questions; transfer questions to tests; and print different forms of tests. Search-and-sort features enable the instructor to locate questions quickly and arrange them in a preferred order. The TestGen plug-in allows the instructor to administer TestGen tests in CourseCompass QuizMaster, working with your school's computer network, automatically grades the exams, stores the results on a disk, and allows the instructor to view and print a variety of reports. Online Mini-Case PowerPoint Presentations. A significant addition to the instructor's resources in this new Fourteenth Edition, each of the 18 Mini-Cases has a stand-alone PowerPoint presentation available online. Online PowerPoint Presentation Slides. The extensive set of PowerPoint slides, prepared by Sonya Britt of Kansas State University, provides lecture outlines and selected graphics from the text for each chapter. All of the teaching resources are available online for download at the Instructor Resource Center at www.pearsonhighered.com and on the catalog page for Multinational Business Finance. A01_MOFF9872_14_SE_FM.indd 8 12/06/15 10:02 pm Preface ix International Editions Multinational Business Finance has been used throughout the world to teach students of international finance. Our books are published in a number of foreign languages including Chinese, French, Spanish, Indonesian, Portuguese, and Ukrainian. Acknowledgments The authors are very thankful for the many detailed reviews of previous editions and suggestions from a number of colleagues. The final version of Multinational Business Finance, Fourteenth Edition, reflects most of the suggestions provided by these reviewers. The survey reviewers were anonymous, but the detailed reviewers were: Jennifer Foo, Stetson University John Gonzales, University of San Francisco Delroy M. Hunter, University of Southern Florida Chee K. Ng, Fairleigh Dickinson University Richard L. Patterson, Indiana University, Bloomington Sanjiv Sabherwal, University of Texas at Arlington Tzveta Vateva, Kent State University Special thanks are extended to the reviewers and survey participants of the previous editions: Otto Adleberger Essen University, Germany Alan Alford Northeastern University Stephen Archer Willamette University Bala Arshanapalli Indiana University Northwest Hossein G. Askari George Washington University Robert T. Aubey University of Wisconsin at Madison David Babbel University of Pennsylvania James Baker Kent State University Morten Balling Arhus School of Business, Denmark Arindam Bandopadhyaya University of Massachusetts at Boston Ari Beenhakker University of South Florida Carl Beidleman Lehigh University Robert Boatler Texas Christian University A01_MOFF9872_14_SE_FM.indd 9 Gordon M. Bodnar Johns Hopkins University Nancy Bord University of Hartford Finbarr Bradley University of Dublin, Ireland Tom Brewer Georgetown University Michael Brooke University of Manchester, England Robert Carlson Assumption University, Thailand Kam C. Chan University of Dayton Chun Chang University of Minnesota Sam Chee Boston University Metropolitan College Kevin Cheng New York University It-Keong Chew University of Kentucky Frederick D. S. Choi New York University Jay Choi Temple University Nikolai Chuvakhin Pepperdine University Mark Ciechon University of California, Los Angeles J. Markham Collins University of Tulsa Alan N. Cook Baylor University Kerry Cooper Texas A&M University Robert Cornu Cranfield School of Management, U.K. Roy Crum University of Florida Steven Dawson University of Hawaii at Manoa David Distad University of California, Berkeley Gunter Dufey University of Michigan, Ann Arbor Mark Eaker Duke University Rodney Eldridge George Washington University Imad A. Elhah University of Louisville 12/06/15 10:02 pm x Preface Vihang Errunza McGill University Cheol S. Eun Georgia Tech University Mara Faccio University of Notre Dame Larry Fauver University of Tennessee Joseph Finnerty University of Illinois at Urbana-Champaign William R. Folks, Jr. University of South Carolina Lewis Freitas University of Hawaii at Manoa Anne Fremault Boston University Fariborg Ghadar George Washington University Ian Giddy New York University Martin Glaum Justus-Lievig-Universitat Giessen, Germany Deborah Gregory University of Georgia Robert Grosse Thunderbird Christine Hekman Georgia Tech University Steven Heston University of Maryland James Hodder University of Wisconsin, Madison Alfred Hofflander University of California, Los Angeles Janice Jadlow Oklahoma State University Veikko Jaaskelainen Helsinki School of Economics and Business Administration Benjamas Jirasakuldech University of the Pacific Ronald A. Johnson Northeastern University Fred Kaen University of New Hampshire John Kallianiotis University of Scranton A01_MOFF9872_14_SE_FM.indd 10 Charles Kane Boston College Robert Kemp University of Virginia W. Carl Kester Harvard Business School Seung Kim St. Louis University Yong Kim University of Cincinnati Yong-Cheol Kim University of Wisconsin-Milwaukee Gordon Klein University of California, Los Angeles Steven Kobrin University of Pennsylvania Paul Korsvold Norwegian School of Management Chris Korth University of South Carolina Chuck C. Y. Kwok University of South Carolina John P. Lajaunie Nicholls State University Sarah Lane Boston University Martin Laurence William Patterson College Eric Y. Lee Fairleigh Dickinson University Yen-Sheng Lee Bellevue University Donald Lessard Massachusetts Institute of Technology Arvind Mahajan Texas A&M University Rita Maldonado-Baer New York University Anthony Matias Palm Beach Atlantic College Charles Maxwell Murray State University Sam McCord Auburn University Jeanette Medewitz University of Nebraska at Omaha Robert Mefford University of San Francisco Paritash Mehta Temple University Antonio Mello University of Wisconsin at Madison Eloy Mestre American University Kenneth Moon Suffolk University Gregory Noronha Arizona State University Edmund Outslay Michigan State University Lars Oxelheim Lund University, Sweden Jacob Park Green Mountain College Yoon Shik Park George Washington University John Petersen, George Mason University Harvey Poniachek New York University Yash Puri University of Massachusetts at Lowell R. Ravichandrarn University of Colorado at Boulder Scheherazade Rehman George Washington University Jeff Rosenlog Emory University David Rubinstein University of Houston Alan Rugman Oxford University, U.K. R. J. Rummel University of Hawaii at Manoa Mehdi Salehizadeh San Diego State University Michael Salt San Jose State University Roland Schmidt Erasmus University, the Netherlands Lemma Senbet University of Maryland 12/06/15 10:02 pm Preface Alan Shapiro University of Southern California Hany Shawky State University of New York, Albany Hamid Shomali Golden Gate University Vijay Singal Virginia Tech University Sheryl Winston Smith University of Minnesota Luc Soenen California Polytechnic State University Marjorie Stanley Texas Christian University Joseph Stokes University of Massachusetts-Amherst Jahangir Sultan Bentley College Lawrence Tai Loyola Marymount University Kishore Tandon CUNYBernard Baruch College Russell Taussig University of Hawaii at Manoa Lee Tavis University of Notre Dame Sean Toohey University of Western Sydney, Australia Norman Toy Columbia University Joseph Ueng University of St. Thomas Gwinyai Utete Auburn University Rahul Verma University of Houston-Downtown Harald Vestergaard Copenhagen Business School K. G. Viswanathan Hofstra University Joseph D. Vu University of Illinois, Chicago Mahmoud Wahab University of Hartford Masahiro Watanabe Rice University Michael Williams University of Texas at Austin Brent Wilson Brigham Young University Bob Wood Tennessee Technological University Alexander Zamperion Bentley College Emilio Zarruk Florida Atlantic University Tom Zwirlein University of Colorado, Colorado Springs Industry (present or former affiliation) Paul Adaire Philadelphia Stock Exchange xi Barbara Block Tektronix, Inc. Holly Bowman Bankers Trust Payson Cha HKR International, Hong Kong John A. Deuchler Private Export Funding Corporation Kre Dullum Gudme Raaschou Investment Bank, Denmark Steven Ford Hewlett Packard David Heenan Campbell Estate, Hawaii Sharyn H. Hess Foreign Credit Insurance Association Aage Jacobsen Gudme Raaschou Investment Bank, Denmark Ira G. Kawaller Chicago Mercantile Exchange Kenneth Knox Tektronix, Inc. Arthur J. Obesler Eximbank I. Barry Thompson Continental Bank Gerald T. West Overseas Private Investment Corporation Willem Winter First Interstate Bank of Oregon A note of thanks is also extended to our accuracy reviewer, Dev Prasad, of the University of Massachusetts Lowell. We would also like to thank all those with Pearson Education who have worked so diligently on this edition: Kate Fernandes, Kathryn Dinovo, and Meredith Gertz. In addition, Gillian Hall, our outstanding project manager at The Aardvark Group, deserves much gratitude. Finally, we would like to dedicate this book to our parents, the late Wilford and Sylvia Eiteman, the late Harold and Norma Stonehill, and Bennie Ruth and the late Hoy K. Moffett, who gave us the motivation to become academicians and authors. We thank our wives, Keng-Fong, Kari, and Megan, for their patience while we were preparing Multinational Business Finance, Fourteenth Edition. Pacific Palisades, California D.K.E. Honolulu, Hawaii A.I.S. Glendale, Arizona M.H.M. A01_MOFF9872_14_SE_FM.indd 11 12/06/15 10:02 pm About the Authors David K. Eiteman. David K. Eiteman is Professor Emeritus of Finance at the John E. Anderson Graduate School of Management at UCLA. He has also held teaching or research appointments at the Hong Kong University of Science & Technology, Showa Academy of Music (Japan), the National University of Singapore, Dalian University (China), the Helsinki School of Economics and Business Administration (Finland), University of Hawaii at Manoa, University of Bradford (U.K.), Cranfield School of Management (U.K.), and IDEA (Argentina). He is a former president of the International Trade and Finance Association, Society for Economics and Management in China, and Western Finance Association. Professor Eiteman received a B.B.A. (Business Administration) from the University of Michigan, Ann Arbor (1952); M.A. (Economics) from the University of California, Berkeley (1956); and a Ph.D. (Finance) from Northwestern University (1959). He has authored or co-authored four books and twenty-nine other publications. His articles have appeared in The Journal of Finance, The International Trade Journal, Financial Analysts Journal, Journal of World Business, Management International, Business Horizons, MSU Business Topics, Public Utilities Fortnightly, and others. Arthur I. Stonehill. Arthur I. Stonehill is a Professor of Finance and International Business, Emeritus, at Oregon State University, where he taught for 24 years (1966-1990). During 1991-1997 he held a split appointment at the University of Hawaii at Manoa and Copenhagen Business School. From 1997 to 2001 he continued as a Visiting Professor at the University of Hawaii at Manoa. He has also held teaching or research appointments at the University of California, Berkeley; Cranfield School of Management (U.K.); and the North European Management Institute (Norway). He was a former president of the Academy of International Business, and was a western director of the Financial Management Association. Professor Stonehill received a B.A. (History) from Yale University (1953); an M.B.A. from Harvard Business School (1957); and a Ph.D. in Business Administration from the University of California, Berkeley (1965). He was awarded honorary doctorates from the Aarhus School of Business (Denmark, 1989), the Copenhagen Business School (Denmark, 1992), and Lund University (Sweden, 1998). He has authored or co-authored nine books and twenty-five other publications. His articles have appeared in Financial Management, Journal of International Business Studies, California Management Review, Journal of Financial and Quantitative Analysis, Journal of International Financial Management and Accounting, International Business Review, European Management Journal, The Investment Analyst (U.K.), Nationalkonomisk Tidskrift (Denmark), Sosialkonomen (Norway), Journal of Financial Education, and others. xii A01_MOFF9872_14_SE_FM.indd 12 Michael H. Moffett. Michael H. Moffett is Continental Grain Professor in Finance at the Thunderbird School of Global Management at Arizona State University, where he has been since 1994. He also has held teaching or research appointments at Oregon State University (1985-1993); the University of Michigan, Ann Arbor (1991-1993); the Brookings Institution, 12/06/15 10:02 pm About the Authors xiii Washington, D.C.; the University of Hawaii at Manoa; the Aarhus School of Business (Denmark); the Helsinki School of Economics and Business Administration (Finland), the International Centre for Public Enterprises (Yugoslavia); and the University of Colorado, Boulder. Professor Moffett received a B.A. (Economics) from the University of Texas at Austin (1977), an M.S. (Resource Economics) from Colorado State University (1979), an M.A. (Economics) from the University of Colorado, Boulder (1983), and Ph.D. (Economics) from the University of Colorado, Boulder (1985). He has authored, co-authored, or contributed to a number of books, articles, case studies, and other publications. He has co-authored two books with Art Stonehill and David Eiteman, Fundamentals of Multinational Finance, and this book, Multinational Business Finance. His articles have appeared in the Journal of Financial and Quantitative Analysis, Journal of Applied Corporate Finance, Journal of International Money and Finance, Journal of International Financial Management and Accounting, Contemporary Policy Issues, Brookings Discussion Papers in International Economics, and others. He has contributed to a number of collected works including the Handbook of Modern Finance, the International Accounting and Finance Handbook, and the Encyclopedia of International Business. He is also co-author of two books in multinational business with Michael Czinkota and Ilkka Ronkainen, International Business (7th Edition) and Global Business (4th Edition), and The Global Oil and Gas Industry: Strategy, Finance, and Management, with Andrew Inkpen. A01_MOFF9872_14_SE_FM.indd 13 12/06/15 10:02 pm Brief Contents Part 1 Global Financial Environment 1 Chapter 1 M \u0007 ultinational Financial Management: Opportunities and Challenges 2 Chapter 2 The International Monetary System 28 Chapter 3 The Balance of Payments 57 Chapter 4 Financial Goals and Corporate Governance 87 Part 2 Foreign Exchange Theory and Markets 117 Chapter 5 Chapter 6 Chapter 7 Chapter 8 Chapter 9 The Foreign Exchange Market 118 International Parity Conditions 147 Foreign Currency Derivatives: Futures and Options 181 Interest Rate Risk and Swaps 209 Foreign Exchange Rate Determination 241 Part 3 Foreign Exchange Exposure 273 Chapter 10 Transaction Exposure 274 Chapter 11 Translation Exposure 313 Chapter 12 Operating Exposure 331 Part 4 Financing the Global Firm 357 Chapter 13 Chapter 14 Chapter 15 Chapter 16 The Global Cost and Availability of Capital 358 Raising Equity and Debt Globally 384 Multinational Tax Management 421 International Trade Finance 450 Part 5 Foreign Investments and Investment Analysis 477 Chapter 17 Foreign Direct Investment and Political Risk 478 Chapter 18 Multinational Capital Budgeting and Cross-Border Acquisitions 510 Answers to Selected End-of-Chapter Problems 545 Glossary549 Index565 xiv A01_MOFF9872_14_SE_FM.indd 14 12/06/15 10:02 pm Contents Part 1 Global Financial Environment 1 Chapter 1 Multinational Financial Management: Opportunities and Challenges 2 Financial Globalization and Risk 3 The Global Financial Marketplace 4 The Theory of Comparative Advantage 11 What Is Different about International Financial Management? 13 Market Imperfections: A Rationale for the Existence of the Multinational Firm 14 The Globalization Process 15 Summary Points 19 Mini-Case: Crowdfunding Kenya 19 Questions Problems Internet Exercises 22 Chapter 2 The International Monetary System 28 History of the International Monetary System 29 IMF Classification of Currency Regimes 33 Fixed versus Flexible Exchange Rates 37 A Single Currency for Europe: The Euro 39 Emerging Markets and Regime Choices 42 Globalizing the Chinese Renminbi 44 Summary Points 48 Mini-Case: IcelandA Small Country in a Global Crisis 49 Questions Problems Internet Exercises 54 Chapter 3 The Balance of Payments 57 Fundamentals of BOP Accounting 58 The Accounts of the Balance of Payments 60 BOP Impacts on Key Macroeconomic Rates 68 Trade Balances and Exchange Rates 70 Capital Mobility 72 Summary Points 77 Mini-Case: Global Remittances 78 Questions Problems Internet Exercises 82 Chapter 4 Financial Goals and Corporate Governance 87 Who Owns the Business? 87 The Goal of Management 90 Publicly Traded versus Privately Held: The Global Shift 96 Corporate Governance 99 Summary Points 107 Mini-Case: Luxury WarsLVMH vs. Herms 108 Questions Problems Internet Exercises 112 xv A01_MOFF9872_14_SE_FM.indd 15 12/06/15 10:02 pm xvi Contents Part 2 Foreign Exchange Theory and Markets 117 Chapter 5 The Foreign Exchange Market 118 Functions of the Foreign Exchange Market 119 Structure of the Foreign Exchange Market 119 Transactions in the Foreign Exchange Market 123 Size of the Foreign Exchange Market 126 Foreign Exchange Rates and Quotations 129 Summary Points 138 Mini-Case: The Venezuelan Bolivar Black Market 139 Questions Problems Internet Exercises 142 Chapter 6International Parity Conditions 147 Prices and Exchange Rates 148 Interest Rates and Exchange Rates 155 Forward Rate as an Unbiased Predictor of the Future Spot Rate 164 Prices, Interest Rates, and Exchange Rates in Equilibrium 165 Summary Points 167 Mini-Case: Mrs. Watanabe and the Japanese Yen Carry Trade 167 Questions Problems Internet Exercises 170 Appendix: An Algebraic Primer to International Parity Conditions 177 Chapter 7 Foreign Currency Derivatives: Futures and Options 181 Foreign Currency Futures 182 Currency Options 184 Option Pricing and Valuation 192 Advanced Topic: Currency Option Pricing Sensitivity 193 Summary Points 200 Mini-Case: KiKos and the South Korean Won 200 Questions Problems Internet Exercises 203 Appendix: Currency Option Pricing Theory 207 Chapter 8Interest Rate Risk and Swaps 209 Interest Rate Foundations 210 Interest Rate Risk 217 Interest Rate Futures and FRAs 220 Interest Rate Swaps 222 Cross-Currency Swaps 226 Summary Points 230 Mini-Case: Argentina and the Vulture Funds 231 Questions Problems Internet Exercises 236 Chapter 9 Foreign Exchange Rate Determination 241 Exchange Rate Determination: The Theoretical Thread 242 Currency Market Intervention 247 Disequilibrium: Exchange Rates in Emerging Markets 253 Forecasting in Practice 258 Summary Points 263 Mini-Case: Russian Ruble Roulette 263 Questions Problems Internet Exercises 266 A01_MOFF9872_14_SE_FM.indd 16 12/06/15 10:02 pm Contents xvii Part 3 Foreign Exchange Exposure 273 Chapter 10 Transaction Exposure 274 Types of Foreign Exchange Exposure 274 Why Hedge? 275 Ganado's Transaction Exposure 280 Risk Management in Practice 289 Advanced Topics in Hedging 290 Summary Points 292 Mini-Case: China Noah Corporation 292 Questions Problems Internet Exercises 298 Appendix: Complex Option Hedges 305 Chapter 11 Translation Exposure 313 Overview of Translation 314 Translation Methods 315 Ganado Corporation's Translation Exposure 318 Managing Translation Exposure 322 Summary Points 325 Mini-Case: McDonald's, Hoover Hedges, and Cross-Currency Swaps 325 Questions Problems Internet Exercises 327 Chapter 12Operating Exposure 331 A Multinational's Operating Exposure 331 Measuring Operating Exposure: Ganado Germany 336 Strategic Management of Operating Exposure 341 Proactive Management of Operating Exposure 344 Summary Points 350 Mini-Case: Toyota's European Operating Exposure 350 Questions Problems Internet Exercises 353 Part 4 Financing the Global Firm 357 Chapter 13 The Global Cost and Availability of Capital 358 Financial Globalization and Strategy 358 International Portfolio Theory and Diversification 361 The Demand for Foreign Securities: The Role of International Portfolio Investors 367 The Cost of Capital for MNEs Compared to Domestic Firms 372 Summary Points 375 Mini-Case: Novo Industri A/S (Novo) 376 Questions Problems Internet Exercises 379 Chapter 14 Raising Equity and Debt Globally 384 Designing a Strategy to Source Capital Globally 385 Optimal Financial Structure 386 Optimal Financial Structure and the Multinational 387 Raising Equity Globally 389 Depositary Receipts 393 Private Placement 399 Foreign Equity Listing and Issuance 400 A01_MOFF9872_14_SE_FM.indd 17 12/06/15 10:02 pm xviii Contents Raising Debt Globally 403 Summary Points 408 Mini-Case: Petrobrs of Brazil and the Cost of Capital 409 Questions Problems Internet Exercises 412 Appendix: Financial Structure of Foreign Subsidiaries 417 Chapter 15 Multinational Tax Management 421 Tax Principles 422 Multinational Tax Management 429 Tax Havens and International Offshore Financial Centers 435 Google: An Illustrative Case of Profit Repositioning 437 Corporate Inversion 439 Summary Points 440 Mini-Case: Apple's Global iTax Strategy 441 Questions Problems Internet Exercises 445 Chapter 16International Trade Finance 450 The Trade Relationship 450 Benefits of the System 453 Key Documents 455 Government Programs to Help Finance Exports 462 Trade Financing Alternatives 463 Forfaiting: Medium- and Long-Term Financing 466 Summary Points 468 Mini-Case: Crosswell International and Brazil 469 Questions Problems Internet Exercises 472 Part 5 Foreign Investments and Investment Analysis 477 Chapter 17 Foreign Direct Investment and Political Risk 478 Sustaining and Transferring Competitive Advantage 479 The OLI Paradigm and Internationalization 481 Deciding Where to Invest 483 Modes of Foreign Investment 484 Illustrative Case: Corporate Competition from the Emerging Markets 488 Predicting Political Risk 490 Country-Specific Risk: Transfer Risk 496 Country-Specific Risk: Cultural and Institutional Risk 499 Global-Specific Risk 502 Summary Points 505 Mini-Case: Strategic Portfolio Theory, Black Swans, and [Avoiding] Being the Turkey 506 Questions Internet Exercises 508 A01_MOFF9872_14_SE_FM.indd 18 12/06/15 10:02 pm Contents xix Chapter 18 Multinational Capital Budgeting and Cross-Border Acquisitions510 Complexities of Budgeting for a Foreign Project 511 Illustrative Case: Cemex Enters Indonesia 514 Real Option Analysis 527 Project Financing 528 Cross-Border Mergers and Acquisitions 529 Summary Points 535 Mini-Case: Elan and Royalty Pharma 535 Questions Problems Internet Exercises 539 Answers to Selected End-of-Chapter Problems 545 Glossary549 Index565 A01_MOFF9872_14_SE_FM.indd 19 12/06/15 10:02 pm This page intentionally left blank A01_MOFF9872_14_SE_FM.indd 20 12/06/15 10:02 pm Part 1 Global Financial Environment Chapte r 1 Multinational Financial Management: Opportunities and Challenges Chapt e r 2 The International Monetary System Chapt e r 3 The Balance of Payments Chapt e r 4 Financial Goals and Corporate Governance 1 M01A_MOFF9872_14_SE_P01.indd 1 12/06/15 10:02 pm Chapter 1 Multinational Financial Management: Opportunities and Challenges The objects of a financier are, then, to secure an ample revenue; to impose it with judgment and equality; to employ it economically; and, when necessity obliges him to make use of credit, to secure its foundations in that instance, and for ever, by the clearness and candor of his proceedings, the exactness of his calculations, and the solidity of his funds. Edmund Burke, Reflections on the Revolution in France, 1790, p. 467. Lea rni ng O bje cti v e s Understand the complexity of risks associated with financial globalization Explore how global capital markets are critical for the exchange of products, services, and capital in the execution of global business Consider how the theory of comparative advantage establishes the foundations for the justification for international trade and commerce Discover what is different about international financial management, and which market imperfections give rise to the multinational enterprise Examine how imperfections in global markets translate into opportunities for multinational enterprises Consider how the globalization process moves a business from a purely domestic focus in its financial relationships and composition to one truly global in scope The subject of this book is the financial management of multinational enterprises (MNEs) multinational financial management. MNEs are firmsboth for-profit companies and notfor-profit organizationsthat have operations in more than one country and conduct their business through branches, foreign subsidiaries, or joint ventures with host country firms. That conduct of business comes with challenges as suggested by the following news release from Procter & Gamble Co. (P&G), an American multinational consumer goods company: \"The October-December 2014 quarter was a challenging one with unprecedented currency devaluations,\" said Chairman, President and Chief Executive Officer A.G. Lafley. \"Virtually every currency in the world devalued versus the U.S. dollar, with the Russian Ruble leading the way. While we continue to make steady progress on the strategic 2 M01B_MOFF9872_14_SE_C01.indd 2 12/06/15 10:03 pm Multinational Financial Management: Opportunities and Challenges CHAPTER 1 3 transformation of the companywhich focuses P&G on about a dozen core categories and 70 to 80 brands, on leading brand growth, on accelerating meaningful product innovation and increasing productivity savingsthe considerable business portfolio, product innovation, and productivity progress was not enough to overcome foreign exchange.\" P&G News Release, January 27, 2015. P&G is not alone. New MNEs are appearing all over the world every day, while many of the older and established ones (like P&G) are struggling to survive. Businesses of all kinds are seeing a very different world than in the past. Today's MNEs depend not only on the emerging markets for cheaper labor, raw materials, and outsourced manufacturing, but also increasingly on those same emerging markets for sales and profits. These marketswhether they are emerging, less developed, or developing, or are BRIC (Brazil, Russia, India, and China), BIITS (Brazil, India, Indonesia, Turkey, South Africa, which are also termed the Fragile Five), or MINT (Mexico, Indonesia, Nigeria, Turkey)represent the majority of the earth's population and, therefore, the majority of potential customers. And adding market complexity to this changing global landscape is the risky and challenging international macroeconomic environment, both from a long-term and short-term perspective. The global financial crisis of 2008-2009 is already well into the business past, and capital is flowing againalthough both into and out of economiesat an ever-increasing pace. How to identify and navigate these risks is the focus of this book. These risks may all occur on the playing field of the global financial marketplace, but they are still a question of managementof navigating complexity in pursuit of the goals of the firm. Financial Globalization and Risk Back in the halcyon pre-crisis days of the late 20th and early 21st centuries, it was taken as self evident that financial globalization was a good thing. But the subprime crisis and eurozone dramas are shaking that belief. . . . what is the bigger risk nowparticularly in the eurozoneis that financial globalization has created a system that is interconnected in some dangerous ways. \"Crisis Fears Fuel Debate on Capital Controls,\" Gillian Tett, Financial Times, December 15, 2011. The theme dominating global financial markets today is the complexity of risks associated with financial globalizationfar beyond whether it is simply good or bad, but how to lead and manage multinational firms in the rapidly moving marketplace. The following is but a sampling of this complexity of risks. M01B_MOFF9872_14_SE_C01.indd 3 The international monetary system, an eclectic mix of floating and managed fixed exchange rates, is under constant scrutiny. The rise of the Chinese renminbi is changing much of the world's outlook on currency exchange, reserve currencies, and the roles of the dollar and the euro (see Chapter 2). Large fiscal deficits, including the current eurozone crisis, plague most of the major trading countries of the world, complicating fiscal and monetary policies, and ultimately, interest rates and exchange rates (see Chapter 3). Many countries experience continuing balance of payments imbalances, and in some cases, dangerously large deficits and surpluseswhether it be the twin surpluses enjoyed by China, the current account surplus of Germany amidst a sea of eurozone deficits, or the continuing current account deficit of the United States, all will inevitably move exchange rates (see Chapter 3). 12/06/15 10:03 pm 4 CHAPTER 1 Multinational Financial Management: Opportunities and Challenges Ownership, control, and governance vary radically across the world. The publicly traded company is not the dominant global business organizationthe privately held or family-owned business is the prevalent structureand goals and measures of performance vary dramatically between these business models (see Chapter 4). Global capital markets that normally provide the means to lower a firm's cost of capital, and even more critically, increase the availability of capital, have in many ways shrunk in size and have become less open and accessible to many of the world's organizations (see Chapter 2). Today's emerging markets are confronted with a new dilemma: the problem of first being the recipients of capital inflows, and then of experiencing rapid and massive capital outflows. Financial globalization has resulted in the ebb and flow of capital into and out of both industrial and emerging markets, greatly complicating financial management (Chapters 5 and 8). This first chapter is meant only as an introduction and a taste of the complexity of risks associated with financial globalization. The Mini-Case at the end of this first chapter, Crowdfunding Kenya, is intended to push you in your thinking about how and why money moves across the globe today. The Global Financial Marketplace Businessdomestic, international, globalinvolves the interaction of individuals and individual organizations for the exchange of products, services, and capital through markets. The global capital markets are critical for the conduct of this exchange. The global financial crisis of 2008-2009 served as an illustration and a warning of how tightly integrated and fragile this marketplace can be. Assets, Institutions, and Linkages Exhibit 1.1 provides a map of the global capital markets. One way to characterize the global financial marketplace is through its assets, institutions, and linkages. Assets. The assetsfinancial assetsat the heart of the global capital markets are the debt securities issued by governments (e.g., U.S. Treasury Bonds). These low-risk or risk-free assets form the foundation for the creation, trading, and pricing of other financial assets like bank loans, corporate bonds, and equities (stock). In recent years, a number of additional securities have been created from existing securitiesderivatives, the value of which is based on market value changes of the underlying securities. The health and security of the global financial system relies on the quality of these assets. Institutions. The institutions of global finance are the central banks, which create and control each country's money supply; the commercial banks, which take deposits and extend loans to businesses, both local and global; and the multitude of other financial institutions created to trade securities and derivatives. These institutions take many shapes and are subject to many different regulatory frameworks. The health and security of the global financial system relies on the stability of these financial institutions. Linkages. The links between the financial institutionsthe actual fluid or medium for exchangeare the interbank networks using currency. The ready exchange of currencies in the global marketplace is the first and foremost necessary element for the conduct of financial trading, and the global currency markets are the largest markets in the world. The exchange of currencies, and the subsequent exchange of all other securities globally via currency, is the M01B_MOFF9872_14_SE_C01.indd 4 12/06/15 10:03 pm Multinational Financial Management: Opportunities and Challenges CHAPTER 1 E x hib i t 1 .1 5 Global Capital Markets The global capital market is a collection of institutions (central banks, commercial banks, investment banks, not-forprofit financial institutions like the IMF and World Bank) and securities (bonds, mortgages, derivatives, loans, etc.), which are all linked via a global networkthe Interbank Market. This interbank market, in which securities of all kinds are traded, is the critical pipeline system for the movement of capital. Public Debt Mortgage Loan Corporate Loan Corporate Bond Bank Interbank Market (LIBOR ) Bank Currency Currency Currency Private Debt Private Equity Bank Central Banks Institutions The exchange of securitiesthe movement of capital in the global financial systemmust all take place through a vehiclecurrency. The exchange of currencies is itself the largest of the financial markets. The interbank market, which must pass-through and exchange securities using currencies, bases all of its pricing through the single most widely quoted interest rate in the worldLIBOR (the London Interbank Offered Rate). international interbank network. This network, whose primary price is the London Interbank Offered Rate (LIBOR), is the core component of the global financial system. The movement of capital across currencies and continents for the conduct of business has existed in many different forms for thousands of years. Yet, it is only within the past 50 years that these capital movements have started to move at the pace of an electron in the digital marketplace. And it is only within the past 20 years that this market has been able to reach the most distant corners of the earth at any moment of the day. The result has been an explosion of innovative products and servicessome for better and some for worse. And as illustrated by Global Finance in Practice 1.1, conditions and markets can changeoften quickly. The Market for Currencies The price of any one country's currency in terms of another country's currency is called a f oreign currency exchange rate. For example, the exchange rate between the U.S. dollar ($ or USD) and the European euro ( or EUR) may be stated as \"1.0922 dollar per euro\" or simply abbreviated as $1.0922/. This is the same exchange rate as when stated \"EUR1.00 = USD1.0922.\" Since most international business activities require at least one of the two parties in a business transaction to either pay or receive payment in a currency that is different from their own, an understanding of exchange rates is critical to the conduct of global business. Currency Symbols. As noted, USD and EUR are often used as the symbols for the U.S. dollar and the European Union's euro. These are the computer symbols (ISO-4217 codes) used today on the world's digital networks. The field of international finance, however, has a rich history of using a variety of different symbols in the financial press, and a variety of different M01B_MOFF9872_14_SE_C01.indd 5 12/06/15 10:03 pm 6 CHAPTER 1 Multinational Financial Management: Opportunities and Challenges Global Finance in Practice 1.1 The Rocketing Swiss Franc The Swiss franc has been fighting its appreciation against the European euro for years. While it is not a member of the European Union and while its currency has been one of the world's most stable for over a century, Switzerland is an economy and a currency completely encased within the Eurozone. In 2011, in an attempt to stop the Swiss franc from continuing to grow in value against the euro (to stop its appreciation), the Swiss Central Bank announced a \"floor\" on its value against the euro of 1.20 Swiss francs to one euro. To preserve this value, the Bank would intervene in the market by buying euros with Swiss francs anytime the market exchange rate threatened to hit the floor. As illustrated in Exhibit A, the Bank had to intervene only a few select times in the past three yearsuntil early 2015. In early 2015, the markets continued to apply upward pressure on the Swiss franc's value against the euro (which means pushing its exchange value to less than 1.20 Swiss francs per euro). The Swiss Central Bank continued to intervene, buying euros with Swiss